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Question: How to file lump-sum 401(K) distributions with HMRC

Question: How to file lump-sum 401(K) distributions with HMRC

Old Jan 23rd 2024, 10:30 am
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Default Question: How to file lump-sum 401(K) distributions with HMRC

I'm hoping I can call on the collective experience of the forum to help me with a niggling question about lump-sum distributions from 401(K) accounts to a UK resident / taxpayer. I know this comes up regularly in the forum, and to be clear I'm very familiar with the DTA as written (e.g. Article 17(2)) and not looking to repeat this. However, there seems to be much conflicting advice (including from tax professionals, including mine, and HMRC advisors themselves) on how to go about reporting the lump-sum to HMRC, or if it is indeed taxable at all in the UK.

There appears to be broadly two schools of thought:

1) Article 17(2) is implemented and the Lump-Sum is only taxed in the USA (with no tax liability in the UK).

2) The whole the Lump-Sum is taxable in the USA, but also taxable in the UK by the invocation of the 'Savings Clause' in Article 1, paras (4) & (5). Relief from 'Double Taxation' is also claimed on the HMRC self-assessment as permitted by Article 24.

I was hoping that others that have been through this recently could share your experience. I have 3 questions I'd like to answer:

Q1: Which approach did you take?
Q2: What was the feedback from HMRC (if any)? I'm thinking knowledge of HMRC push-back to the approach would be useful in gauging the overall HMRC position here, but no feedback is also good to know.
Q3: Did you include any comments/declarations on the HMRC self-assessment form, and if so, what were these?

I appreciate that not everyone will be comfortable sharing this information publicly, so feel free to message me privately if you wish.

Thanks in advance for any help you can give.

Gary P
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Old Jan 23rd 2024, 11:47 am
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Default Re: Question: How to file lump-sum 401(K) distributions with HMRC

My wife and I rolled over our 401ks into IRAs and then started doing conversions from them into Roth IRAs with US taxes being paid on the conversion amounts. We did this from the first year we retired in 2010 and had not completely finished the conversions for my wife before we moved back. My wife did her last conversion in 2021 and it was only taxed by the IRS. The London based tax accountant we use to do both our US and UK tax returns declared the conversion in the comments section of the Self Assessment (section 19 - Any Other Information). HMRC have not got back to her on this so are either okay with this or didn't read the comment. This US/UK dual qualified tax accountant does many returns every year so I have every confidence that HMRC won't come back to this return in later years, but who knows.

Remember that I am just some guy on the internet so do your own due diligence.
During the 2021 calendar year, I did a Roth Conversion in respect of my Vanguard Pension Fund of $xxx and, since this is a lump sum from a US plan, it is subject to US tax only and exempt from UK tax and has therefore not been included in this return.
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Old Jan 23rd 2024, 2:48 pm
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Default Re: Question: How to file lump-sum 401(K) distributions with HMRC

Originally Posted by durham_lad
My wife and I rolled over our 401ks into IRAs and then started doing conversions from them into Roth IRAs with US taxes being paid on the conversion amounts. We did this from the first year we retired in 2010 and had not completely finished the conversions for my wife before we moved back. My wife did her last conversion in 2021 and it was only taxed by the IRS. The London based tax accountant we use to do both our US and UK tax returns declared the conversion in the comments section of the Self Assessment (section 19 - Any Other Information). HMRC have not got back to her on this so are either okay with this or didn't read the comment. This US/UK dual qualified tax accountant does many returns every year so I have every confidence that HMRC won't come back to this return in later years, but who knows.

Remember that I am just some guy on the internet so do your own due diligence.
Thanks for your reply durham_lad. I assume that your rollovers from 401(k) to IRA, and then IRA to Roth IRA did not result and any distribution of funds. If this is the case, then the rollovers would not attract UK tax as they are covered under the DTA Article 18(1). The IRS treat the tax on the Roth Conversion as a 'charge', rather than a tax on income which would attract UK tax. Incidentally, I have started to rollover my 401(k) to a Roth IRA, and fortunately my plan does this as a direct transfer with out any withholding (which could be regarded as a distribution) so I'm comfortable in using the same approach in the future.

My question relates to a distribution of funds from my 401(k) directly. I took one payment and don't plan to take another, which means I can comfortably describe it as non-periodic and a lump-sum. IRS have taxed is as such. The question I posted was how to deal with the HMRC? Which of the two options I outlined apply? Its all a bit uncertain and I'm not convinced by the variability of advice from consultants and HMRC advisors, hence my plea for real world feedback based on experience.

Cheers

Gary P

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Old Jan 23rd 2024, 3:08 pm
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Default Re: Question: How to file lump-sum 401(K) distributions with HMRC

Originally Posted by GPilky
Thanks for your reply durham_lad. I assume that your rollovers from 401(k) to IRA, and then IRA to Roth IRA did not result and any distribution of funds. If this is the case, then the rollovers would not attract UK tax as they are covered under the DTA Article 18(1). The IRS treat the tax on the Roth Conversion as a 'charge', rather than a tax on income which would attract UK tax. Incidentally, I have started to rollover my 401(k) to a Roth IRA, and fortunately my plan does this as a direct transfer with out any withholding (which could be regarded as a distribution) so I'm comfortable in using the same approach in the future.

My question relates to a distribution of funds from my 401(k) directly. I took one payment and don't plan to take another, which means I can comfortably describe it as non-periodic and a lump-sum. IRS have taxed is as such. The question I posted was how to deal with the HMRC? Which of the two options I outlined apply? Its all a bit uncertain and I'm not convinced by the variability of advice from consultants and HMRC advisors, hence my plea for real world feedback based on experience.

Cheers

Gary P
I’ve not gone directly from 401k to Roth as the IRA to Roth within the same brokerage over a number of years was very easy to manage online. The 401k to IRA had zero tax consequences and then the code on the IRA to Roth conversions always showed “7 - Normal Distribution “ and were taxed exactly like a normal distribution, but as you say the distributions never went into our bank account. Once you have held a Roth IRA (any Roth IRA) for 5 years or more and are over age 59.5 then there is no restriction on withdrawing from the Roth so one could do IRA to Roth and then immediately distribute from the Roth if it made a difference. (Roth distributions are definitely tax free in the UK)

Last edited by durham_lad; Jan 23rd 2024 at 3:47 pm.
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Old Jan 23rd 2024, 3:43 pm
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Default Re: Question: How to file lump-sum 401(K) distributions with HMRC

Originally Posted by GPilky
1) Article 17(2) is implemented and the Lump-Sum is only taxed in the USA (with no tax liability in the UK).
I can't provide an answer taken from experience but I'm a few years away from drawing down my 401k/IRA while maybe living in the UK so I'm beginning to research the mechanics of that. The US doesn't distinguish between periodic and lump-sum distributions from such accounts - it's all regular income to the IRS as you know. I'm just getting up to speed on the various tax treaty rules so I'm interested in the same question as you. Does HMRC allow the 25% tax-free lump-sum rule on foreign pensions? And if so, how many lump sums can you withdraw within a given time window? I expect all my 401k/IRA withdrawals to be 'ad-hoc' and different year-to-year so does that count as multiple lump sums?

With regard to the savings clause - this gives the US the right to override some aspects of tax treaties and allows the US to tax its citizens on some income which the treaty otherwise would exempt. In the case of pension lump sums, the notes for para 17(2) explain that the US will tax lump sums that are tax free in the UK to avoid double non taxation (see the treaty notes). So it's definitely taxable in the US even without applying the savings clause. So your question boils down the the HMRC treatment of a single foreign pension lump sum, and my question expands that to the actual definition of a lump sum and can you have more than one?


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Old Jan 23rd 2024, 3:59 pm
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Default Re: Question: How to file lump-sum 401(K) distributions with HMRC

HMRC’s own website indicates that lump sums to a UK resident from a US pension scheme shall only be taxed in the USA. The question then is what is the difference between a lump sum and periodic distributions. If you take one lump sum every year or every other year would they count as lumps or periodic?

https://www.gov.uk/hmrc-internal-man...relief/dt19853

A lump-sum payment derived by a resident of one State from a pension scheme established in the other State shall be taxable only in that other State.
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Old Jan 23rd 2024, 4:02 pm
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Default Re: Question: How to file lump-sum 401(K) distributions with HMRC

Originally Posted by durham_lad
.....Once you have held a Roth IRA (any Roth IRA) for 5 years or more and are over age 59.5 then there is no restriction on withdrawing from the Roth so one could do IRA to Roth and then immediately distribute from the Roth if it made a difference. (Roth distributions are definitely tax free in the UK)
As I understand it the 5 year holding requirement is to allow distribution of any 'earnings' tax free, however, you are able to remove your own (Tax Paid) funds at any time without penalty. Is my understanding correct?

Gary P

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Old Jan 23rd 2024, 4:26 pm
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Default Re: Question: How to file lump-sum 401(K) distributions with HMRC

Originally Posted by Pierre_Tete
With regard to the savings clause - this gives the US the right to override some aspects of tax treaties and allows the US to tax its citizens on some income which the treaty otherwise would exempt. In the case of pension lump sums, the notes for para 17(2) explain that the US will tax lump sums that are tax free in the UK to avoid double non taxation (see the treaty notes). So it's definitely taxable in the US even without applying the savings clause. So your question boils down the the HMRC treatment of a single foreign pension lump sum, and my question expands that to the actual definition of a lump sum and can you have more than one?
Hi.... It seems you are asking similar questions to me. In my research around Article 17(2) I too found the 'Notes' you refer to not only in the DTA notes, but also guidance documents in the UK Pensions manual and other locations. The original intent of Article 17(2) as written into the DTA was clearly to close a loop-hole that allowed US citizens resident in the UK from taking advantage of the 25% tax free lump sum paid in the UK, thus reducing US tax. However, some have questioned whether the savings clause could also apply.

Below is a copy of a statement made by HMRC on their customer forum explaining the logic of this:

"Lump Sum Payments

There is no legislative definition of a lump sum but HMRC regards these as being any non-periodic payment of a pension, that is, any non-regular payment that decreases the value of the remaining pension pot after such payment is made. For example, the first (IRA) withdrawal is taken in year 1, the next withdrawal was made in year 5, and another withdrawal in year 7, such payments will not be regarded as periodic and will be treated as lump sums under the UK/USA Double Taxation Agreement (DTA). Whereas any amount withdrawn in set, periodic, frequent intervals, that is weekly, monthly, annually and so on would not be a lump sum, but rather periodic payments.

Article 17(2) of the UK/USA DTA provides the US with the right to tax any lump sum payment which is made from a US sourced pension scheme, including IRAs. However, the UK is also permitted to tax the same lump sum payment(s), which is in accordance with Article 1(4) of the DTA, both Article 17(2) and Article 1(4) are outlined below and, when read from the perspective of a UK resident, state:

Article 17(2) - Notwithstanding the provisions of paragraph 1 of this Article, a lump-sum payment derived from a pension scheme established in a Contracting State [USA] and beneficially owned by a resident of the other Contracting State [UK] shall be taxable only in the first-mentioned State [USA].

Article 1(4) - Notwithstanding any provision of this Convention except paragraph 5 of this Article, a Contracting State [UK and/or USA] may tax its residents, and by reason of citizenship may tax its citizens, as if this Convention had not come into effect.

A UK resident, Article 1(4) above permits the UK to tax any US sourced lump sum payment received, as if Article 17(2) of the DTA was not in force or applicable, Article 1(4) effectively ‘overrides’ the provision at Article 17(2), and the consequence is that both the UK and USA can tax any lump sum payment received from a US sourced pension scheme.

In these situations, double taxation will occur since both the UK and the USA can tax the same income. However, that double taxation will be eliminated in accordance with Article 24(4)(a) of the DTA which requires the UK, as the country of residence, to provide Foreign Tax Credit Relief (FTCR) to offset the US tax correctly paid against the UK tax charged on the same the IRA withdrawal."


Having said this, after a year of looking I have not seen any comments online saying that this is what happens in practice. Nor have any tax consultants I have spoken to indicated this is the case either. The opinion given is that 17(2) applies and that tax is only due in the US and not in the UK.

I'm wondering if the comments made by HMRC above are a theoretical possibility not implemented in practice and not policy, unless this is about to change?

Gary P

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Old Jan 23rd 2024, 4:36 pm
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Default Re: Question: How to file lump-sum 401(K) distributions with HMRC

Originally Posted by durham_lad
HMRC’s own website indicates that lump sums to a UK resident from a US pension scheme shall only be taxed in the USA. The question then is what is the difference between a lump sum and periodic distributions. If you take one lump sum every year or every other year would they count as lumps or periodic?
I assume that you are referring to the following?"Lump Sums

A lump-sum payment derived by a resident of one State from a pension scheme established in the other State shall be taxable only in that other State.

The provision preserves the exemption from income tax of a lump sum relevant benefit where it is paid by a UK approved pension scheme to a beneficial owner who is a US resident. However, Article 1(4) will apply in respect of US citizens as the provisions of Article 17(2) are not amongst those listed at Article 1(5). So, the US can tax lump sums received by US citizens from UK schemes."

I'm not sure why this note is worded from a US perspective and my assumption is that it is because it was requested by the US to close a loophole. However, Article 1(4) applies to both contracting states so (in theory at least) could be also used by HMRC to tax 'lump sums received by UK Citizens (& residents) from US Schemes"?

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Old Jan 23rd 2024, 4:42 pm
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Default Re: Question: How to file lump-sum 401(K) distributions with HMRC

Originally Posted by GPilky
As I understand it the 5 year holding requirement is to allow distribution of any 'earnings' tax free, however, you are able to remove your own (Tax Paid) funds at any time without penalty. Is my understanding correct?

Gary P
Yes, I believe you are correct, but once over age 59.5 it doesn’t matter as long as you have held any Roth for at each 5 years. For example, suppose you opened a Roth at age 55. At age 59.5 or older you could put new money into a new Roth either by contributions or conversions and withdraw from it, including earnings, tax free without leaving it for 5 years.

This means that your point above about 401k and IRA distributions being treated differently by HMRC than Roth distributions can easily be overcome by converting 401k money to a Roth, paying US taxes only and then immediately withdrawing that money tax free in both countries.

This is similar to a “backdoor Roth” for folks who earn too much to contribute directly to a Roth. They make a non-deductible contribution to a traditional IRA then immediately convert it to a Roth.
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Old Jan 23rd 2024, 4:47 pm
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Default Re: Question: How to file lump-sum 401(K) distributions with HMRC

Originally Posted by GPilky
I assume that you are referring to the following?"Lump Sums

A lump-sum payment derived by a resident of one State from a pension scheme established in the other State shall be taxable only in that other State.

The provision preserves the exemption from income tax of a lump sum relevant benefit where it is paid by a UK approved pension scheme to a beneficial owner who is a US resident. However, Article 1(4) will apply in respect of US citizens as the provisions of Article 17(2) are not amongst those listed at Article 1(5). So, the US can tax lump sums received by US citizens from UK schemes."

I'm not sure why this note is worded from a US perspective and my assumption is that it is because it was requested by the US to close a loophole. However, Article 1(4) applies to both contracting states so (in theory at least) could be also used by HMRC to tax 'lump sums received by UK Citizens (& residents) from US Schemes"?

Gary P
I don’t believe HMRC use the savings clause to get around this issue like the IRS does, and this HMRC website is pointing out that lump sums from UK pension schemes to US citizens can be taxed by the IRS.
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